Ch03 Parkin Demand Supply

3 DEMAND AND SUPPLY
After studying this chapter, you will be able to:

 Describe a competitive market and think about a
price as an opportunity cost
 Explain the influences on demand
 Explain the influences on supply
 Explain how demand and supply determine prices
and quantities bought and sold
 Use the demand and supply model to make
predictions about changes in prices and quantities
© 2014 Pearson Education

• In 2010, the prices of nappa cabbage and kimchi in
Korea rose rapidly.
• Why do some prices rise? And why do some prices

fall, and some fluctuate?
• This chapter answers these questions.
• The demand and supply is the main tool of

economics.
• It explains how prices are determined and how

they guide the use of resources to influence
What, How, and For Whom goods and services
are produced.
What Is a Market?
• A market is a group of buyers and sellers of a

particular good or service.
• The terms supply and demand refer to the

behavior of people . . . as they interact with one
another in markets.
• Buyers determine demand.
• Sellers determine supply.

Markets and Prices
•A competitive market is a market that has many
buyers and many sellers so no single buyer or seller
can influence the price.
•The money price of a good is the amount of money

needed to buy it.
• E.g. price of a book is RM80.
•The relative price of a good— the ratio of the price

of a commodity (such as a good or service) in terms
of another commodity—is its opportunity cost.
• E.g. given the price of two goods - houses and apartments,
where we may observe that the price of houses are
increasing relative to apartment rents.
(Phouses / Papartments) = PRelative 
• This may be due to an increased desire (preferences) for

detached housing.
• A developer would react by allocating resources (land,
labor, materials) to the construction of houses. These
scarce resources would be pulled-away from alternative
uses - apartment construction.
• Results in the construction of more houses and fewer
apartments.
Demand
If you demand something, then you
1. Want it,
2. Can afford it, and
3. Have made a definite plan to buy it.
Wants are the unlimited desires or wishes people
have for goods and services. Demand (DD) reflects
a decision about which wants to satisfy.
The quantity demanded (Qd) of a good or service is
the amount that consumers plan to buy during a
particular time period, and at a particular price.
Demand
The Law of Demand
The law of demand states: Other things remaining
the same, the higher the price of a good, the smaller
is the quantity demanded (P, Qd); and …the
lower the price of a good, the larger is the quantity
demanded (P, Qd)
Why does a change in the price change the quantity
demanded? Two reasons:
 Substitution effect
 Income effect
Demand
Substitution Effect
When the relative price (opportunity cost) of a good
or service rises, people seek substitutes for it, so
the quantity demanded of the good or service
decreases.
Income Effect (real income/purchasing power)

When the price of a good or service rises relative
to income, people cannot afford all the things they
previously bought, so the quantity demanded of the
good or service decreases.
Demand
Demand Curve and Demand Schedule
The term demand refers to the entire relationship
between the price of the good and quantity
demanded of the good.
A demand curve shows the relationship between
the quantity demanded of a good and its price
when all other influences on consumers’ planned
purchases remain the same.

Demand
Figure 3.1 shows a demand curve for energy bars.
As price , Qd

Demand
•   Qd  a
movement up along
the demand curve.
•   Qd  a
movement down along
the demand curve.

Willingness & Ability to Pay and
Marginal Benefit
Marginal benefit
• The benefit that a person receives from
consuming one more unit of a good or service.
• It is measured as the maximum amount that a
person is willing to pay for one more unit.
Decreasing Marginal Benefit
• The more we have of any one good or service,
the smaller is our marginal benefit.

Marginal Benefit
Tapes Willingness to Pay

Possibility (millions per month) (bottles per tape)
a 0.5 5
b 1.5 4
c 2.5 3
d 3.5 2
e 4.5 1

Marginal Benefit
As more and more
Soda (millions of bottles per month)
5
tapes are consumed,
the willingness &
4 ability to pay
decreases, so the
marginal
3
benefit from additional
tapes decreases.
2
1
MB = DD
0 1 2 3 4 5
© 2014 Pearson Education Tapes (millions per month)
Demand Curve and Willingness to Pay
Willingness & Ability to

Pay
A demand curve is also a
willingness & ability-to-pay
curve.
Willingness to pay measures
marginal benefit.
The smaller the quantity
available, the higher is the
price that someone is willing
to pay for another unit, thus
higher MB (point E).

Demand
A Change in the Quantity Demanded Versus a
Change in Demand
A Movement along the Demand Curve
When the price of the good changes and other things
remain the same, the quantity demanded changes
and there is a movement along the demand curve.
A Shift of the Demand Curve
If the price remains the same but one of the other
influences on buyers’ plans changes, demand
changes and the demand curve shifts.
Demand
A Change in Demand
• When some influence on buying plans other than
the price of the good changes, there is a change in
demand for that good.
• The quantity of the good that people plan to buy
changes at each and every price, so there is a new
demand curve.
• When demand   demand curve shifts rightward.
• When demand   demand curve shifts leftward.

Demand
Six main factors that change demand are:
 The prices of related goods (substitutes vs
complement goods)
 Expected future prices
 Income (normal vs inferior goods)
 Expected future income and credit
 Population
 Preferences
Demand
Prices of Related Goods
• A substitute is a good that can be used in place of
another good.
• E.g. When the price of tea , the demand for coffee
 (positive)  demand curve for coffee shifts
rightward.
• A complement is a good that is used in conjunction
with another good.
• E.g. When the price of petrol , the demand for car
 (negative)  demand curve for car shifts leftward.
negative
B
A
positive
https://image.slidesharecdn.com/ch03-110629184923-phpapp02/95/demand-supply-and-market-equilibrium-19-728.jpg?cb=1309375275
Demand
Expected Future Prices
If the price of a good is expected to rise in the future
 current demand for the good   demand curve
shifts rightward.
Income (normal vs inferior)
When income   consumers buy more  demand
curve shifts rightward.
o Normal good is one for which demand increases
as income increases ( Y, DD).
o Inferior good is a good for which demand
decreases as income increases ( Y, DD).
Effect of Income on Demand
(normal versus inferior goods)
( income , demand ) ( income , demand )

positive negative
Demand
Because an energy bar is a normal good, an increase in income
increases the demand for energy bars.

Demand
Number of Population / Composition of
Population
The larger the population, the greater is the demand

– DD curve shift rightward; and vice versa.
•A society with relatively more children, will have a
greater demand for goods and services for children
like tricycles and day-care facilities.
•A society with relatively more elderly persons, will
have a higher demand for nursing homes and
healthcare supports equipment or tools.

Demand
Preferences
People with the same income have different
demands if they have different preferences.
Expected Future Income and Credit

•When income is expected to increase in the future
or when credit is easy to obtain, the demand might
increase now – DD curve shift rightward.

Factors That Shift Demand Curves
https://cdn.kastatic.org/ka-perseus-images/7581e3d3c0ae0d95b83dee0ed304dc89a9239039.jpg
Supply
If a firm supplies a good or service, then the firm
1. Has the resources and the technology to produce it,
2. Can profit from producing it, and
3. Has made a definite plan to produce and sell it.
Resources and technology determine what it is

possible to produce. Supply reflects a decision about
which technologically feasible items to produce.
The quantity supplied (Qs) of a good or service is
the amount that producers plan to sell during a given
time period at a particular price.
Supply
The Law of Supply
The law of supply states:
Other things remaining the same, the higher the price of a
good, the greater is the quantity supplied; and
the lower the price of a good, the smaller is the quantity
supplied.
The law of supply results from the general tendency for the
marginal cost of producing a good or service to increase as
the quantity produced increases.
Producers are willing to supply a good only if they can at least
cover their marginal cost of production.

Supply
Supply Curve and Supply Schedule
The term supply (SS) refers to the entire
relationship between the quantity supplied and the
price of a good.
The supply curve shows the relationship between

the quantity supplied of a good and its price when
all other influences on producers’ planned sales
remain the same.

Supply
A rise in the price, other

things remaining the same,
brings an increase in the
quantity supplied.

Supply
A Change in the Quantity Supplied Versus a Change in
Supply
A Movement Along the Supply Curve
When the price of the good changes and other influences on
sellers’ plans remain the same, the quantity supplied
changes and there is a movement along the supply curve.
A Shift of the Supply Curve
If the price remains the same but some other influence on
sellers’ plans changes, supply changes and the supply curve
shifts.

Supply
A Change in Supply
• When some influence on selling plans other than
the price of the good changes, there is a change in
supply of that good.
• The quantity of the good that producers plan to sell
changes at each and every price, so there is a new
supply curve.
• When supply   supply curve shifts rightward.
•When supply   supply curve shifts leftward.

Supply
The six main factors that change supply of a good
are:
 The prices of factors of production (labour, land,
capital, etc)
 The prices of related goods produced
 Expected future prices
 The number of suppliers
 Technology
 State of nature
Supply
Prices of Factors of Production
• If the price of a factor of production (labour, land,
capital, etc) used to produce a good rises, the
minimum price that a supplier is willing to accept for
producing each quantity of that good rises (cost of
production).
• A rise in the price of a factor of production  
supply  shifts the supply curve leftward.

Supply
Technology
Advances in technology create new products and
lower the cost of producing existing products 
supply  shift the supply curve rightward.
The Number of Suppliers

The larger the number of suppliers of a good, the
greater is the supply of the good and supply curve
shifts rightward.

Factors That Change Supply
https://www.thoughtco.com/thmb/wDEhLOwWRMjyu97zKJimzqSv5G4=/597x359/filters:no_upscale():max_bytes(150000):strip_icc()/Supply-Shifters-5-
56a27da63df78cf77276a5a9.png
Supply
An advance in the technology increases the supply of energy
bars and shifts the supply curve rightward.

Supply
Expected Future Prices
If the price of a good is expected to rise in the future,
supply of the good today decreases and the supply
curve shifts leftward.
The State of Nature

The state of nature includes all the natural forces that
influence production—for example, the weather. A
natural disaster   supply and shifts the supply
curve leftward.

Supply
Prices of Related Goods Produced
• Many firms can produce and sell alternative
products.
•A substitute in production for a good is another good
that can be produced using the same resources.
•The supply of a good increases if the price of a
substitute in production falls.
•Example: A farmer can plant corn or soybeans. If
the price of soybeans rises, he will plant (supply) less
corn - supply decreases (shift leftward).

Substitutes in Production
(rightward shift)
S0
S1
https://image.slidesharecdn.com/module2b-demandandsupply-150714212641-lva1-app6892/95/module-2b-demand-and-supply-29-638.jpg?
cb=1436909266
Supply
• Sometimes, two products are necessarily produced
together.
• Goods are complements in production if they must
be produced together (the production of one good
automatically triggers the production of the other).
• The supply of a good increases if the price of a
complement in production rises.
• Example: Cattle provide both beef and leather. An
increase in the price of beef encourages more cattle
farming, and hence increase the supply of leather
(rightward shift).
Complements in Production
(leftward shift)
S1 S0
These goods are

complements in production
https://image.slidesharecdn.com/module2b-demandandsupply-150714212641-lva1-app6892/95/module-2b-demand-and-supply-28-638.jpg?
cb=1436909266
Market Equilibrium
• Equilibrium is a situation in which opposing forces
balance each other. Equilibrium in a market occurs
when the price balances the plans of buyers (DD)
and sellers (SS).
• The equilibrium price is the price at which the
quantity demanded equals the quantity supplied.
• The equilibrium quantity is the quantity bought and
sold at the equilibrium price.
• Price regulates buying and selling plans. Price
adjusts when plans don’t match.

Market Equilibrium
Figure 3.7 illustrates the market equilibrium—the price at
which quantity demanded equals quantity supplied.
13
15

Market Equilibrium
Price as a Regulator
There is a surplus of 6 million energy bars.
13
15
• At price $2.00 a bar  Qs > Qd 

surplus of 6 million bars.
• At price $1.00 a bar  Qd > Qs 
shortage 9 million bars.
• At price $1.50, no shortage or surplus.

Market Equilibrium
Price Adjustments
• At prices above the
equilibrium price, a surplus
forces the price down.
• At prices below the
equilibrium price, a shortage
forces the price up. A
• At the equilibrium price,
buyers’ plans and sellers’
plans agree and the price
doesn’t change until some
event changes either demand
or supply.

Predicting Changes in Price & Quantity
An Increase in Demand
• When DD   demand
C
• At the original price
($1.50), there is now a
shortage (Qd > Qs). A B
• The P and Qs  along

the supply curve.

An Increase in Supply
• When SS  - supply
• At the original price
($1.50), there is now a
surplus (Qs > Qd). A B
•The P↓ and Qd along C

the demand curve.

All Possible Changes in

Demand and Supply
A change in demand or
supply or both demand A
and supply changes the
equilibrium price and the
equilibrium quantity.

Change in Demand with

No Change in Supply
B
When DD - equilibrium
P and the equilibrium
Q. A

Decrease in Demand
When DD↓ - the

equilibrium P↓ and the
equilibrium Q↓. A

Change in Supply with

No Change in Demand A
When SS - the B

equilibrium P↓ and the
equilibrium Q.

Decrease in Supply
When SS↓ - the B
equilibrium P and the
equilibrium Q↓.
A

Increase in Both Demand

and Supply
An DD  and SS  
A
B
The change in equilibrium
price is uncertain because
the increase in demand
raises the equilibrium price
and the increase in supply
lowers it.

Decrease in Both Demand
and Supply
A decrease in both demand

and supply decreases the
B A
price is uncertain because
the decrease in demand
lowers the equilibrium price
and the decrease in supply
raises it.

Decrease in Demand and
Increase in Supply
A decrease in demand and

an increase in supply
lowers the equilibrium A
price.
The change in equilibrium B

quantity is uncertain
because the decrease in
demand decreases the
equilibrium quantity and
the increase in supply
increases it.
Increase in Demand and
Decrease in Supply
B
An increase in demand and
a decrease in supply raises
the equilibrium price.
A
quantity is uncertain
because the increase in
demand increases the
equilibrium quantity and the
decrease in supply
decreases it.
B B
A A
B A
A B

What Happens to Price and Quantity When
Supply or Demand Shifts?


Ch03 Parkin Demand Supply

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3 DEMAND AND SUPPLY

After studying this chapter, you will be able to:

© 2014 Pearson Education

• Why do some prices rise? And why do some prices

• This chapter answers these questions.

• The demand and supply is the main tool of

• It explains how prices are determined and how

• A market is a group of buyers and sellers of a

• The terms supply and demand refer to the

• Buyers determine demand.

• Sellers determine supply.

© 2014 Pearson Education

•The money price of a good is the amount of money

•The relative price of a good— the ratio of the price

• This may be due to an increased desire (preferences) for

Income Effect (real income/purchasing power)

© 2014 Pearson Education

© 2014 Pearson Education

© 2014 Pearson Education

© 2014 Pearson Education

Tapes Willingness to Pay

© 2014 Pearson Education

Willingness & Ability to

© 2014 Pearson Education

© 2014 Pearson Education

( income , demand ) ( income , demand )

© 2014 Pearson Education

The larger the population, the greater is the demand

© 2014 Pearson Education

Expected Future Income and Credit

© 2014 Pearson Education

Resources and technology determine what it is

© 2014 Pearson Education

The supply curve shows the relationship between

© 2014 Pearson Education

A rise in the price, other

© 2014 Pearson Education

© 2014 Pearson Education

© 2014 Pearson Education

© 2014 Pearson Education

The Number of Suppliers

© 2014 Pearson Education

© 2014 Pearson Education

The State of Nature

© 2014 Pearson Education

© 2014 Pearson Education

These goods are

© 2014 Pearson Education

© 2014 Pearson Education

There is a surplus of 6 million energy bars.

• At price $2.00 a bar  Qs > Qd 

© 2014 Pearson Education

© 2014 Pearson Education

• The P and Qs  along

© 2014 Pearson Education

•The P↓ and Qd along C

© 2014 Pearson Education

All Possible Changes in

© 2014 Pearson Education

Change in Demand with

© 2014 Pearson Education

When DD↓ - the

© 2014 Pearson Education

Change in Supply with